The Affordable Care Act (ACA) provisions mandating both “guaranteed issue” (insurers must sell to everyone) and “community rating” (insurers can’t charge higher rates to high-risk insureds) create a perverse incentive for young, healthy people to forego purchasing costly health insurance until they need medical treatment, at which point they will be assured coverage (because of guaranteed issue) at rates not reflecting their infirmities (because of community rating).

When young, healthy people drop out of the insurance pool, premiums — reflective of the average health care expenditures of the covered population — will rise, driving even more young, healthy people from the pool. To prevent such “adverse selection,” the ACA needs to encourage the young and healthy into the insurance pool, and ensure that they remain covered.

SCOTUS’s opinion upholding the ACA, however, rejected (quite properly) the Act’s mandate to carry insurance and instead read the ACA to impose a “tax” on those who freely opt not to buy insurance. That tax, though, is far too small to induce a great many young, healthy people to stay in the insurance pool — even after the ACA’s generous (i.e., expensive) subsidies are accounted for. And the reasoning of SCOTUS’s majority opinion limits Congress’s ability to raise the no-insurance penalties to an effective level. Thus, adverse selection is inevitable and will tend to drive up the cost of health insurance by “sickening” the pool of insureds and increasing the average number of claims per insured.

Now, an increase in claims per insured would not necessarily raise health insurance premiums ifthe ACA actually reduced the underlying cost of medical services, the primary driver of health insurance premiums. Sadly, though, it does no such thing. The handful of provisions in the 1,000-page statute that are aimed at underlying medical costs, rather than health insurance, range from anemic to silly. Some, such as the requirement that all preventive services be provided with no out-of-pocket expenditure (the requirement underlying the controversial “contraception mandate”), are sure to increase underlying medical costs. After all, what incentive do providers have to compete on the price of preventive services if the individuals making the decision to purchase those services face no marginal cost when deciding whom to patronize?

The fundamental problem with the ACA’s purported cost-saving provisions is that they ignore the primary driver of underlying medical costs: the near complete absence of price competition among health care providers, who know that most individuals making consumption decisions (those with a standard or better health insurance policy) have no “skin in the game,” get no benefit from selecting a cheaper provider, and thus will not tend to award business to providers who are less expensive. This unfortunate result stems largely from the federal tax code, which perversely encourages employees to demand (and employers to provide) such generous health insurance benefits that insurance has now effectively become “pre-paid health care.” The tax code achieves this result by making employer contributions to health plans tax free, while fully taxing any dollars paid instead as salary. As that bastion of free-market ideology, NPR, has reported, economists across the ideological spectrum agree that tax subsidies for employer-provided health insurance drives up the underlying cost of health care. So did President Obama and his team, as evidenced by this op-ed in which Council of Economic Advisers Chair Christina Romer explains how “[e]mployers[‘] … strong incentives to pay workers with more generous insurance policies” tends to “lead families to be less vigilant consumers of health care.” Sadly, President Obama’s shamefully disingeuous 2008 attacks on John McCain’s proposed health care reforms took off the table any treatment of the perverse tax code provisions that largely underlie medical inflation. Ah, the Price of Politics.

So the ACA will drive up the costs of health insurance and underlying medical costs. But isn’t its redeeming virtue the fact that it will drastically expand health insurance coverage? Hardly. First, SCOTUS’s opinion prevents the Feds from forcing states to expand their Medicaid rolls, one of the primary means by which the ACA was to increase health insurance coverage. At this point, ten states (including biggies like Texas and Georgia) are not participating in the Medicaid expansion, five others (including New Jersey and Virginia) are leaning against participation, and fourteen others (including Florida, Michigan, Ohio, and Pennsylvania) are undecided. The upshot is that in a great many populous states, individuals and families that are not Medicaid eligible but earn incomes less than 133% of federal poverty level will receive no subsidy to buy health insurance on an individual basis. Moreover, the plain language of the ACA denies individual purchase subsidies to citizens of states that decline to set up a state insurance exchange. As of January 4, 2013, 25 states had firmly decided not to set up their own exchanges, and several others were in limbo.

The primary reason that the ACA will fail to expand insurance coverage, though, is that it encourages employers of low- to moderate-wage employees to drop health insurance benefits. The media have largely lambasted employers for this move, but it’s actually in the interest of their employees. The ACA, you see, provides generous subsidies to employees who cannot obtain qualifying health insurance from their employers at an affordable price. Those subsidies are far, far larger than the implicit tax subsidy an employee receives for employer-provided health care (by virtue of the fact that compensation paid as health benefits is not taxed). Employees thus have a strong incentive to demand — and employers to provide — a compensation package that consists of higher salary in exchange for no health insurance coverage. In the Regulation article, I run the numbers to show how the ACA creates an incentive for employers to drop coverage and pay a higher salary but fails to incentivize moderately compensated employees to turn around and purchase health insurance. The upshot is that coverage levels are likely to fall.

So this is where we are. The grand promises of reduced health care costs and expanded coverage look ever less credible. As the ACA implodes, watch for calls for a single-payer system. We may start with a Public Option, but I’d be surprised if single-payer’s not where we end up at the end of the day. On the bright side, maybe we can see something groovy like this at the next American Olympics!

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Thom Lambert

I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

One response to Regulation Magazine Cover Article: “How the Supreme Court Doomed the ACA to Failure”

Well thought out article, but I do not see where the SCOTUS doomed the ACA when it fact the ACA was doomed at concept. This legislation does nothing to reduce cost and everything to increase expenses for the working class that are living pay check to pay check as it is.

But maybe the ACA is doing what it was meant to do, it is no secret that the President and most democrats want a single payer socialist healthcare system.